Crony capitalism is a term of derision, and rightly so. Yet, it is widespread in the Global South. Stanford Political Scientist Stephen Haber explains why.
Crony capitalism is widely and publicly derided as the worst form of capitalism. It is considered injurious to the long-term prospects of an economy and the welfare of the masses. Yet, it is a widespread phenomenon in the Global South.
The main reason is that crony capitalism meets the need for investments in capital-starved countries in the Global South, says Stanford University political scientist and historian Stephen Haber.
Crony capitalism is seen as a source of bribes, funds for electioneering, and black money for political leaders primarily in politics to line their pockets. It functions as an engine for the parallel economy.
In his introduction to The Political Economy of Crony Capitalism, Haber says that crony capitalism is frequently offered as an explanation for inefficiencies in economic systems in the developing world. But the phenomenon serves specific functions, he argues.
Haber asks fundamental questions: Why do crony economic systems come into being? If crony capitalism is bad for growth, why has it survived for so long?
Cheap Credit
Crony capitalism is defined as a system in which those close to political authorities (politicians who run the government at any given time) receive favours of significant economic value. These favours enable politically connected economic agents to earn returns or profits above those prevailing in a market where the factors of production are priced independently of political interference.
The pre-eminent factor of production in crony capitalism in the Global South is capital or credit—specifically, cheap credit. In India, crony capitalists obtain cheap credit from Scheduled Commercial Banks (SCBs) and State Banks (SBs) through political contacts. This credit is then funnelled into their enterprises.
Even private banks can be induced to provide credit to politically backed capitalists if they receive economic entitlements from the government. Rules are broken or bent to sustain this tripartite alliance of crony capitalists, politicians, and bankers.
Haber notes that crony capitalists are not only granted cheap credit but also allowed to charge higher prices for their products, which would not be possible under regular competitive market conditions. In cases of international competition, crony capitalists may secure trade barriers to shield their products.
He also highlights the link between licensing and crony capitalism. In systems requiring firms to obtain licences for importing certain key inputs, a friendly government can selectively award licences, creating monopolies for crony capitalists. This enables them to dominate the market unhindered by competition.
The government expects that crony capitalists, backed by cheap credit, will invest in industries, thereby relieving the state of the responsibility of managing enterprises. Crony capitalists boost GDP, provide goods to the masses, and create jobs.
Governments in countries with thriving crony capitalism often use taxpayers’ money to fund crony capitalists. If banks accumulate too many Non-Performing Assets (bad loans), the government injects funds to keep them afloat. The majority of NPAs in banks are linked to crony capitalists.
The political leadership also benefits from the crony capitalist system, as crony capitalists use part of the money provided by the State or secured from banks to bribe politicians. Bank officials, both in the State and private banking sectors, may also receive payouts. The system is corrupt to the core but keeps the economy running.
Absence of Checks and Balances
In advanced countries, the system Haber describes as “Limited Government” prevails. In this system, the role of political leadership in the economy is restricted to maintaining ethical and legal standards, he says. Institutional checks and balances limit the growth of crony capitalism.
In the US, for example, institutional checks and balances subject political leaders to oversight, which prevents the emergence of crony capitalism.
In contrast, many countries in the Global South are governed by autocratic leaders or cabals, who make critical decisions and share the proceeds. Questions or dissent are often met with stern reprisals.
The Global South is a fertile ground for crony capitalism, as many of these countries are either full-fledged autocracies or elected autocracies. Their economies are marked by capital scarcity and governmental inability or unwillingness to invest in and manage industries. Governments hand over these functions to crony capitalists, who pay bribes, take charge, and exploit opportunities. Changes in government rarely affect crony capitalists, as they strike similar deals with new leaders.
Drawbacks
Haber acknowledges that from the point of view of economic growth and distribution, crony capitalism has drawbacks. It encourages the misallocation of resources, with crony capitalists often investing in sectors that are lucrative but not beneficial for the economy or society as a whole.
If rent-seeking becomes the main aim, industries that should not exist are created. Rent-seeking occurs when a businessman seeks to gain wealth without contributing to the benefit of society. The “rent” in rent-seeking refers to economic wealth obtained through the shrewd or potentially manipulative use of resources.
Crony capitalists and their political contacts tend to have short-term horizons, leading them to demand high rates of return even for projects with short maturities. Crony capitalism may, in fact, discourage long-term investments altogether.
Since making money by shortcuts is the main aim, products are sold at high prices. Thus, the retail customer, the common man, bears the entire burden, while the crony capitalist and his political benefactors mint money.
In India, public sector banks have suffered significantly due to NPAs linked to crony capitalists. Economist and activist Prasenjit Bose notes that Indian Scheduled Commercial Banks wrote off nearly INR 10 trillion worth of bad loans in the last five years.
During the 2004-2014 Congress government, for every INR 100 of NPA accumulation in Scheduled Commercial Banks, INR 63.34 was recovered, and only INR 8.62 was written off. However, under the Bharatiya Janata Party’s rule, only INR 31.65 was recovered for every INR 100 of NPA accumulation, while write-offs increased to INR 39.38, Bose observes.
By March 2015, nearly three-quarters of NPAs were attributed to large corporate borrowers, according to Reserve Bank of India Deputy Governor N.S. Vishwanathan.
Without large-scale taxpayer-funded bailouts, many public sector banks would have breached capital adequacy ratios due to losses from these write-offs, as noted in a Reserve Bank of India report in 2021. Public Sector Banks accounted for the majority of the write-offs, representing nearly 63% of the total. The banks retain the right to pursue recovery from borrowers, but this option is not actually pursued, Bose points out.